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Transferring money from your saving account to your checking account affects the M1 and M2 money supplies. The US Federal Reserve classifies money into three categories based on its liquidity. Liquidity refers to how fast the assets in each category can be converted to cash. The three categories are M1, M2 and M3, with the M standing for money. Each lower category is incorporated into the next. For example, the M1 money supply is included with M2, and M1 and M2 money supplies are included in M3. Money moves from one category to another as consumers change their spending and savings patterns.
M1 is the most liquid of the three categories. M1 is the money in your possession and in public circulation. Although coins and bills immediately come to mind, the M1 supply also includes other assets that you can spend as easily as cash. Traveler’s checks, checking accounts and money market accounts are all included in the M1 category. However, the money held by financial institutions, such as banks and credit unions, is not included in the M1 supply.
The M2 category includes the liquid M1 money supplies plus less-liquid forms of money. Savings deposits, time deposits such as certificates of deposits under $100,000, retail money market mutual funds, retirement accounts and US dollars that are held in foreign banks make up the M2 money supply. However, retail money market mutual funds that are held in IRAs and Keogh accounts are not included with M2.
Transferring money from your savings account to your checking account does not change the aggregate money supply. Since your savings and checking accounts are included in M2, moving money from one account to the other does not change the M2 balance. However, savings accounts are not included in the M1 category. Transferring money from savings to checking puts more money in circulation and increases the M1 money supply.
Fluctuating interest rates are one reason why you transfer money between your savings and checking accounts. When interest rates are high, you keep more of your money in M2 accounts, such as money market mutual funds, to earn additional income. When interest rates fall, the lower yield is not enough to justify the inconvenience of keeping your money in a savings account or having your money tied up in a certificate of deposit. As a result, you move your money back into your checking account. The advent of interest-bearing checking accounts keeps more money in M1 circulation since the interest rates are as good as or better than a savings account pays.
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